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Morningstar's sustainability ratings: An opportunity to talk to your clients about responsible investing

The ratings cover about 20,000 mutual funds which span a broad spectrum of both ESG-themed and traditional funds

Jul 29, 2016 @ 12:01 am

By Amy O'Brien

While growth and interest in responsible investing has been strong, however, a TIAA Global Asset Management survey found that many advisers fail to engage their clients on the topic.

Furthermore, the same survey found there is a broad disconnect between advisers and investors on how to define the investment category, as industry terminology and classifications are often unclear. A third of the high net worth investors surveyed, for example, said they have responsible investments in their portfolio, although 95% of advisers surveyed reported that their clients had zero exposure to the category.

To help investors sort through this rapidly expanding and often confusing universe, Morningstar Inc. recently unveiled a new sustainability ratings system for U.S. mutual funds, based on a range of ESG factors and other criteria, with the aim of providing a consistent framework. We believe this system and others like it present an excellent opportunity for advisers to talk about the responsible investment and ESG priorities of their clients and prospects.

Morningstar's sustainability ratings cover about 20,000 mutual funds which span a broad spectrum of both ESG-themed and traditional funds, using company-level sustainability data provided by Sustainalytics, a global responsible investment research firm. Morningstar uses the underlying company data to assess how well individual funds manage ESG risks and opportunities versus other similar funds in their peer groups. The ratings include funds that have more than 50% of assets invested in firms that are rated on ESG factors by Sustainalytics.

Much like its star rating system, Morningstar's sustainability ratings assign between one-and-five “globes” to a fund, with five globes representing a fund in the top 10% of its Morningstar peer category, and one globe representing a fund in the bottom 10% of its category.

While Morningstar has taken sustainability ratings to a deeper level by examining and rating the holdings of mutual funds, other firms, including MSCI, FTSE and Thomson Reuters also provide tools for measuring the ESG performance and risks of individual companies. We believe all of these tools are helpful for understanding some facets of responsible investing, and are useful for a discussion, but that investors and advisors should understand the underlying differences between ratings approaches.

There is no universally accepted company sustainability/ESG rating standard and each provider may have their own assumptions and views. There are other types of responsible investment strategies, such as proxy voting and engaging with company management on ESG issues for example, that may not be captured in this type of analysis or ratings.

While advisers focus on the immediate concerns and priorities of their clients, they are also experiencing a shifting landscape, as the baby boomer generation retires and their children, millennials, inherit great sums of wealth. While millennials are at the beginning of their retirement savings journey, this age group stands to inherit an estimated $30 trillion from their baby boomer parents over the next several decades — a massive sum that will shift the wealth management landscape.

Millennials are now the largest age demographic in the U.S. workforce at 1 in 3 workers. They are a group that tends to seek work that is meaningful and fulfilling, rather than simply earning a paycheck. Millennials are also discerning when it comes to what they buy. They are twice as likely, compared to the rest of investor population, to purchase from a brand based on a company's social and/or environmental impact. Millennials are also more willing to pay a premium for products and services from companies committed to positive social and environmental impact compared to other generations, although this habit has been increasing across other age groups.

What can investment advisers glean from the preferences and buying habits of millennials? It may provide an edge with client retention efforts. One of the biggest risks advisors face is losing clients when wealth is passed down from generation-to-generation. Advisers should build relationships with a whole family and not just the primary decision makers, because the goals and aspirations for each generation are often different.

In TIAA's survey, for example, 87% of millennials reported that they are likely to stay with financial advisers who can talk about responsible investing. In other words, millennials are looking to advisers not only to grow their portfolios, but to provide them with a framework to think about responsible investing so they can invest in a way that makes a positive impact on society and the environment.

There is a clear disconnect in the marketplace today between investors and advisers over what it means to invest with ESG considerations in mind. While interest in the sector continues to grow, important questions remain, such as, how do you define options and approaches? And how do advisors and investors evaluate what is, or is not a responsible investment? Morningstar's new sustainability ratings, which represents one viewpoint, helps bridge the gap by providing both a useful framework for discussion, and a comparison tool that investors can use to help evaluate investment decisions.

As an adviser, you are likely very familiar with your clients' risk tolerance and long-term goals and investment objectives. By further understanding their values and what moves them, you have the potential to deepen your relationships.

Amy O'Brien is managing director and head of TIAA Global Asset Management's responsible investment team

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